General collateral repurchase agreements are agreements in which one or more parties agree to buy a nominal amount of collateral for a predefined period of time and in return to provide the seller with “initial consideration” equal to the market value of the collateral purchased. At the end of the period, the collateral is sold back to the seller in return for “end consideration” equal to the initial consideration plus interest for the defined period at a negotiated rate. Market convention dictates that these repurchase agreements may be traded with the following maturity options: constant maturity date (e.g., overnight, 1 week, 1 month); fixed maturity date (e.g., cash to Sep. 30, 2003); or forward start and maturity date (e.g., from Jul. 1 to Jul. 31, 2003).
Unlike certain types of repurchase agreements in which the collateral being sold is named as part of the definition of the repurchase agreement instrument, general collateral repurchase agreements do not have specific collateral issues named as an integral part of the repurchase agreement instrument. After trade execution, the seller is required to select or allocate the collateral being sold from a defined basket of securities.
Typically, the seller is also permitted to substitute initially allocated securities with other securities during the agreement period. A number of rights of substitution is established for each piece of allocated collateral that specifies the number of times the collateral may be substituted.
The buyer and seller typically transact through an intermediary to preserve their anonymity. The intermediary acts as a counterparty to both the seller and buyer, and passes transaction information to the relevant parties.
In a typical repurchase agreement, the buyer and seller determine the start and end dates of the repurchase agreement that they wish to trade, as well as the number of rights of substitution applied to the collateral.
The interest rate applicable to the repurchase agreement may be a fixed or a variable rate. The value of the end consideration is adjusted when the variable rate changes within the repurchase agreement period. The value of the end consideration is also adjusted when the market value of the collateral changes due to a substitution. Any changes in market value of the securities lent during the repurchase agreement period due to market price fluctuation are handled independently of the intermediary by external clearing entities through margin calls on the seller and buyer.
In the past, collateral allocations and substitutions have been arbitrarily controlled by the intermediary conducting the trade. For example, the intermediary was free to arbitrarily select the order of allocations and substitutions amongst buyers in a multi-party transaction. This often resulted in the collateral of particular buyers being substituted in a disproportionately high number of cases while the collateral allocations of other buyers were preserved.